Clay & Company » A Texas Commercial Real Estate Blog

An interesting article published in The New York Times about specialty investments like cell towers and data centers.
By Alison Gregor

Real estate investment trusts, or REITs, have largely outperformed other investment vehicles in the sluggish economy of the last few years. But one subset — “specialty” trusts that invest in real estate other than the four major groups of office, retail, residential and industrial — has been exceptionally solid.

Such trusts that fall into the specialty category can have trouble attracting investors, who often perceive them as being risky, real estate experts said. Typical investment assets are cellphone towers, cold storage warehouses, or transportation and energy infrastructure, among other things.

“What we’ve seen is these specialty or noncore property types have actually done pretty well this year,” said Steve Shigekawa, a co-manager of the Neuberger Berman Real Estate fund, which has about $378 million under management and has invested in several unusual REITs, for timber, self-storage properties and data centers. “You’ve seen pretty consistent demand, and growth in net operating income has actually been better than in the more traditional sectors.”

While the Dow Jones U.S. Real Estate Investment Trusts index shows a year-to-date total return of 3.32 percent, the Dow Jones U.S. Specialty REITs index shows a return of 7.94 percent.

Markets that drive the demand for assets of the specialty REITs tend to be different from the four core trust classes, which can make some of them particularly good investment opportunities in tough economic times, real estate experts said. Self-storage businesses, for example, are obvious beneficiaries of the increase in housing foreclosures and the downsizing of American homes, said Stacy Chitty, a managing partner at Blue Vault Partners, a Georgia company that tracks the performance of public nontraded REITs.

Another sector is data storage centers, which are growing because of increased Internet usage, which seems to be recession-proof. Mr. Chitty mentioned mortgage and real estate-related debt instruments and health care assets as other areas that could flourish in the coming year despite a poor economy.

Entertainment Properties Trust, a REIT that invests primarily in megaplex theaters, has benefited from a shift toward inexpensive entertainment in hard economic times. “Theaters have tended to be a touch countercyclical — not wildly, but a touch,” said David Brain, the chief executive of Entertainment Properties Trust, “and that proved itself in this most recent recession” in which 2009 was a record year for the trust. The REITs lumped together into the specialty basket are actually a diverse group of companies with unusual lines of business that can provide singular opportunities for investors, real estate experts said.

While the National Association of Real Estate Investment Trusts no longer has a “specialty” category, it places some of the more unusual trusts into a sector called “diversified,” said Ronald C. Kuykendall, the group’s vice president of communications.

Some REITs considered specialty in the past, like those investing in self-storage properties, health care assets and timber, have become individual sectors in themselves, Mr. Kuykendall said.

“If a sector gets large enough that it has a significant enough market capitalization, like timber REITs or self-storage, that becomes a sector,” Mr. Kuykendall said, rather than falling into the “diversified” class.

Breaking out of the specialty category has been a boon for the self-storage trusts, said Clint Halverson, a senior director of investor relations for Extra Space Storage Inc., a real estate investment trust based in Salt Lake City, said. The four self-storage REITs now have an equity market capitalization of $27 billion.

“Whereas before when we were lumped into specialty,” he said, “you had to market your brand more to investors. It was a little bit more work to get your name out there, and you had to clarify the story and help investors to understand the value proposition in your stock.”

Because REITs that invest in real estate outside the mainstream are often structured differently from traditional ones, financial planners and institutional investors have more research to do in formulating their real estate portfolio strategies. For example, specialty trusts often have an operating business linked with their real estate assets, said Thomas M. Ray, the president and chief executive of the CoreSite Realty Corporation, a REIT that invests in data centers based in Denver.

“Many of the specialty REITs have more of an operational component to them than the traditional four food groups in real estate,” Mr. Ray said. “Because that operating component is so much more important and larger in many of the specialty sectors, then expertise and specialization matter.”

For instance, CoreSite acquires, builds and operates data centers, which house the huge servers necessary to store data for businesses with growing Internet needs. Those unfamiliar with operating these types of businesses might have difficulties predicting the cash-flows of a business doing so.

A lack of consistent and long-term performance measures and the small size of some of the niche markets also can make specialty REITs harder to grasp for investors, he said.

“More of the specialty REITs came on the scene in the last 10 years or so,” Mr. Ray said, “so you have newer products in these specialty REITS that people need to get to know better, and I think that process is still under way.”

But for the data center REITs, a growing track record is helping overcome investors’ lack of experience and misgivings regarding the riskiness of the nontraditional real estate sector. Of the three data center REITs, with a total equity market capitalization of about $8 billion, two are well north of $1 billion, and “that is somewhat of a bright line for some large institutional investors,” Mr. Ray said. “Some investors say, ‘If you’re less than a billion, it’s harder for me to get the size of position I want and harder for me to move in and out of the stock.’ ”